Basic Points

• Alpha is the outperformance of an index. 
• The idea of alpha is that a portfolio has special strategies and methodologies which set it apart and allow it to have stronger risk-adjusted returns than an index, which is already notoriously difficult to outperform over the long run. 
• Edge (a competitive advantage) is often associated with alpha since it is an advantage that makes one competitive in the trading arena.

Intermediate: Alpha and its Meaning for Traders

While it is difficult to be a consistently profitable trader, the reason why hard-working traders should not be discouraged is that many of the unprofitable traders simply do not put in the effort required to outperform an index. They also often lack the best tools, such as what we provide for you and update each day. If only looking at the hardest-working traders who have good tools and want to improve, then suddenly the odds become much more promising.

Fund managers look to develop alpha over time by showing how their funds can outperform an index. However, it is important to check which index they are using as a baseline. It should generally be something relevant such as SPY, QQQ (if tech heavy), IWM (if a smallcap fund) or an individual sector ETF (a basket of securities that can be traded like a single stock). But if they are choosing a low-performing index for convenience, then that is important to know.

Alpha is typically the hottest buzzword among traders. Despite that, it can be a dangerous trap to give alpha too much weight, especially if a high amount of beta/leverage (amplified size) is used. Beta can easily be confused for alpha if there is a lot of path-dependency luck (profit depending on specific outcomes) involved, such as it being a leveraged long-only portfolio during a bull market. 

It is also important to understand the limitations of alpha: If a strategy is determined to have alpha, usually by means of backtesting (emulating strategies against historical data) then it is a common mistake for traders to jump into the trade without thinking through the timing, size, or volatility (percentage range based on 68.3% confidence) environment. To be more prudent, a high-alpha trade should be thought of more as a setup, but one still needing a trigger. The reason for this is that it is not necessarily profitable to outperform a sinking baseline. Alpha in strategies also tends not to last very long before cooling down.